FDIC looks to reign in compensation via insurance levy

FDIC Chairperson Sheila Bair has released her own proposal to compete with a recently floated proposal for a tax on bank compensation. Her proposal calls for linking compensation with FDIC insurance levies as a means of aligning incentives in the banking industry going forward. In contrast, the competing initiative calls for a one-off ‘windfall’ tax as a means of recouping bonus money due to be paid out by large financial institutions.

In announcing her competing plan, Bair said:

A broad consensus of academic studies agrees that poorly designed compensation structures can misalign incentives and induce risk taking. I share those concerns. The recent crisis has shown that compensation practices that encourage excessive risk can create significant losses in the financial system and the deposit insurance fund.

What I like about Bair’s proposal is that it is designed both as a longer-term solution and meant to align compensation with the larger systemic risks, which Bair explicitly mentions in the quote above. On the other hand, I see the windfall tax proposal as a gimmick designed to harness the public’s outrage on a serious issue and misdirect it toward a one-off political ploy. Windfall taxes are not going to change systemic issues on risk, compensation and moral hazard, whereas the insurance levy does move in that direction.

The public is right to be angry about excessive compensation in financial services. The real issue in compensation has to do with individuals being compensated in the present for riskier bets which appear to accrue higher payoffs in the near-term but have disastrous consequences longer-term. Imposing a one-off tax does nothing to eliminate this problem. Tying compensation and risk together does.

What angers me personally is that this banker windfall tax appears to be a naked ploy to quell voter anger. The tax offers superficially satisfying populist solutions which fail to address any of the more systemic issues that led to the financial crisis. After the one-off tax, it’s back to business as usual on Wall Street. This seems to be a solution designed to win votes and nothing more. Let’s hope Bair wins the day in the Obama Administration’s internal politics.

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty five years of business experience. He has also been a regular economic and financial commentator in print and on television for the past decade. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College.